Major Opportunities Ahead for Kodiak Oil & Gas

If you're a risk taker, small-cap exploration and production companies are one energy subsector you'll want to take a look at. These are some of the riskiest companies in the energy industry, but they offer tremendous upside if they manage to hit pay dirt. Kodiak Oil & Gas (NYS: KOG) is one to watch.

Company overview
Kodiak is a small-cap energy exploration and production company. The company's operations are mainly focused in the Bakken shale of the Williston Basin of North Dakota and Montana.

Kodiak has a market capitalization of around $2.5 billion and shares currently trade a little higher than $9. As with most small-cap explorers and producers, the company's stock price is highly volatile, with a 52-week range of $3.59-$10.75.

Kodiak's growth in production over recent years is nothing short of remarkable. In 2010, the company was cranking out just 1,290 barrels of oil equivalent per day on average. Last year, that number rose to 3,920 barrels of oil equivalent per day. And since then, average production has more than tripled.

In the first quarter of this year, it was at 10,580 boe/d, and in the second quarter, at 12,700 boe/d, which represents 20% sequential growth. The company projects its average for the year will be between 17,000-21,000 boe/d and expects a highly ambitious exit rate of 27,000.

Business strategy and competitive advantages
The company's overarching business strategy is to create shareholder value through growth in reserves, production, and cash flow. Kodiak plans to improve the value of its resource potential through continued acreage expansion in the Williston Basin, the most recent of which was a major acquisition closed in January of this year. Encouraged by strong results from its producing wells, as well as $100-plus oil prices, the company is concentrating all of its capital resources this year in the Williston.

Kodiak believes that its extensive experience in advanced drilling and completion techniques, access to drilling rigs, its pressure pumping services agreement, and its high level of working interest in its properties all contribute to the company's competitive advantage.

As the company builds out its expertise in the application of horizontal drilling and multi-stage isolated fracture stimulations, further cost improvements through efficiency gains are likely. In addition, improvements in these drilling and completion methods should also serve to improve well performance gradually, which should, in turn, boost estimated ultimate recovery rates and rates of return.

One thing I especially like about Kodiak is that it maintains operational control of most of its development and drilling operations. This gives it control over the timing and selection of additional drilling prospects. But more importantly, it allows for greater flexibility in terms of allocating capital, as the company can shift resources to more economical wells with better rates of return with relative ease.

Kodiak's highly concentrated 155,000 net acreage position is prospective for the Bakken and Three Forks formations. Through its own drilling program, as well as drilling by other E&Ps, the risk on this acreage has been largely reduced. This is a very positive sign, since it not only boosts the company's proved reserves, but also means that most of its drilling operations this year will be low-risk, developmental drilling.

After spending a substantial amount of time last year in evaluating well bore spacing in the Middle Bakken and Three Forks formations, the company estimates that its drilling inventory should last for roughly 8-10 years with its current rig count. As additional operations are completed in these two locations, the company expects that the number of drilling locations could increase further.

Final thoughts
Overall, Kodiak has a very straightforward business strategy. The company is almost entirely focused on the Williston Basin, where it has amassed roughly 155,000 net leasehold acres. It aims to continue developing this acreage, which it has done quite successfully so far, with the near-term goal of achieving a year-end exit rate of 27,000 barrels of oil equivalent per day.

While focusing all of its operations on one area is very risky, it is lucky that area is the Bakken, one of the most prolific oil plays ever discovered in North America. Here, Kodiak has amassed a vast inventory of around 800 net drilling locations, of which the majority are proved but undeveloped.

And given the company's estimates that this drilling inventory should last 8-10 years, Kodiak should have plenty of room to grow production. With its relatively high weighting toward oil - 86% as of the last estimate - the company should be able to continue ramping up production, barring a sustained collapse in oil prices.

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